Richard Russell: Markets in danger of shuddering, tilting and falling over

Richard Russell, famous market analyst and writer of the Dow Theory Letters, is regarded as the doyen of investment newsletter writers. And rightly so as the 86-year-old is one of the few men still around to tell us first hand about the Great Depression and how similar today’s economy feels.

Russell, like any investor, has not always been right with his market forecasts. While he has been dead wrong on equity markets for most of the bull market since March last year, he has been one of the few commentators who have been spot on with their predictions of the great bull market in gold right from the starting blocks in 2001.

The gold price in US dollars has risen from $250 at the beginning of 2001 to $1 345 today. This represents an incredible return of 438% (or 20.6% on an annual basis) over this time period. Had you invested your money in global equities, as represented by the MSCI World Index, over the same period, with dividends reinvested, your investment would have shown a paltry return of 25%, or 2.3% annualized. While Russell has been wrong about two strong equity bull markets during this period, from March 2003 to October 2007 and again from March 2009 to date (see graph at bottom), it is doubtful whether anyone got his or her timing in and out of the market exactly right. On the other hand, long-term investors who heeded Russell’s advice to steer clear of the equity market and rather put their bets on gold are smiling all the way.

Russell is of the opinion that the bull market in gold still has a considerable way to go. His view is based on his distrust of the fiat dollar. He believes the US Federal Reserve’s strategy of printing dollars to get the economy out of trouble is going to have disastrous consequences for the dollar and eventually the US economy, and that gold will be one of the few “currencies” that will retain their value.

And what does Russell have to say about the U.S. stock market currently? He does not paint a very pretty picture. Russell says: “Right now, we’re seeing the results of a bubble in Fed-created liquidity. When the water continues to pour into a bath-tub, everything – the rubber ducks, the plastic boats, the soap bars – float up with the water line. This goes on until either the water flows over the tub and onto the floor – or mom comes in and pulls the plug.

“I think that’s what we’re experiencing now in the markets. Everything tradeable − stocks, bonds, gold, silver, commodities in general – is rising. I call it an all-around mega-bubble. It will continue until someone, purposely, or by mistake, pulls the plug.

“There are only two items that seem immune to the surging liquidity: home prices and unemployment. But there’s another possibility. Build a tower out of children’s blocks. You can build that tower just so high, and at some point the last block is too much. The tower shudders, it tilts and falls over.”

While I am not quite as negative on the prospects for equities over the longer term, I am very aware of the risks that still prevail and the possibility of a further correction. However, I do agree with Russell about the long-term bull market in gold not being over yet.